- The Trump administration's decision to abandon the bid to repeal and replace Obamacare capped off a week in which we got more evidence that the narrative driving markets has cracked.- Does that mean this all falls apart completely on Monday?- No. But it does mean the writing is on the Wall.- Herein, find the data and the charts that back up that assessment.

But this particular post isn't a doomsday prophecy. Rather, the idea is simply that over the past several days, we've gotten quite a bit of evidence to suggest that the narrative driving markets has cracked and that likely presages an unwind of some kind.

Does that mean the S&P (NYSEARCA:SPY) is going to promptly crater on Monday morning or that 10Y yields (NYSEARCA:TLT) are going to abruptly crash to post-crisis lows in a mad dash to safety that catalyzes massive short-covering in the 3-sigma Treasury short and drives a stake through the heart of the global reflation story?

No. That's not what it means. Or at least I hope not (reminder: Heisenberg is your friend - he wants you to make money contrary to popular belief).

What it means is that the honeymoon ended when the GOP bid to repeal and replace Obamacare failed.

Donald Trump's Friday afternoon move to cancel the vote on the new health care bill served as confirmation of what markets had already begun to price. Namely that the contentiousness of the health care debate presaged nothing good with regard to the timetable for tax reform and fiscal stimulus, two pillars of the reflation narrative that's propelled risk assets higher since early November.

With that as the backdrop, consider that according to EPFR Global data, U.S. equity funds saw net outflows of $8.9B, last week, the largest in 38 weeks or, in context, the most since the Brexit referendum. As BofAML wrote on Friday citing the same data, "outflows from U.S. value funds were the largest in 66 weeks [while] outflows from U.S. small caps were the largest in 24 weeks."

That marks something of a reversal of fortune considering the fact that retail inflows have been variously cited as the proximate cause for YTD gains in stocks.

Speaking of retail inflows and the impact on the S&P, consider the following out Friday from RBC's Charlie McElligott:

The Quant-Insight PCA macro factor model shows that the long-term (250d) model for SPX pricing shows that 'shares outstanding' increases in SPY ETF have been the second largest factor sensitivity for SPX, i.e. the shift from active to passive from both institutions and retail flows has been a massively important price support for SPX.

This relationship 'peaked' in the "post- US election through Jan '17" period… and has since collapsed precipitously, down to 'zero' in fact. Thus, increases in SPY shares outstanding are showing no impact on SPX short-term prices.

The takeaway seems to be this: not only are retail flows reversing, they don't matter anymore anyway.

Now, consider another sign that the reflation story has cracked. In CFTC data through Tuesday, the 10Y Treasury short was trimmed aggressively to its least short since November while the eurodollar short hit a new record:

(Deutsche Bank, CFTC, my additions)

So that suggests 10Y shorts trimmed their positions following the collapse in yields that accompanied the "dovish" Fed hike while eurodollar shorts rose above 3 million contracts (more here).

I don't know about you, but to me that doesn't seem to suggest folks have very much confidence in the idea of a steeper curve.

Relatedly, the latest Lipper data shows investors yanked the most money from bank sector funds in more than year over the last week, as the Fed's "dovish" hike exacerbated fears that popular Trump trades may have run their course.

Meanwhile, have a look at the following chart which shows how the equity of companies with the highest tax rates have performed versus the broad market since the election:

(Goldman)

"Investors have reduced expectations for the timing and size of tax reform," Goldman wrote on Friday afternoon, adding that "after outperforming the S&P 500 by 520 bp post-election, our basket of stocks with the highest effective tax rates has given back all of its post-election gains in the last three months."

Now that the GOP has failed to push through health care reform, can you imagine what that chart is going to look like in a couple of weeks? Remember, repealing and replacing the ACA was billed as a prerequisite for moving ahead with tax reform.

Again, none of this means that everything is going to suddenly come unglued on Monday.

Why Facts Don’t
Change Our Minds

You and I are both rational beings who let facts drive our
thinking, but it seems our fellow humans are not so thoughtful. Or at least
that’s what the research says. It turns out that behavioral psychologists have
been undermining the bastions of human reasonability for decades, starting with
some nefarious characters in the Stanford University psych department back in
the ’70s, whose devilishly clever experiments were then taken a frightening
step further at that equally suspect institution over on the other coast:
Harvard. Don’t these mental types have anything better to do than conclusively
prove that nobody (but you and I) can think straight?

Apparently not. And then the Harvard guys had the temerity to
suggest that the human race’s muddleheadedness goes allllllll the way back to
the time we spent trotting around on the African savannah. Remember that? Lotsa
fun – if you didn’t get chewed up by a pack of hyenas or run down by a herd of
water buffalos. You see, we weren’t just sitting out there on the plain playing
checkers or debating the finer points of Cartesian philosophy. No, we were
hanging on by the skin of our teeth – even as our teeth got smaller so our
brains could get bigger. But it turns out that the most significant way our
brains got bigger – and the main reason we survived and evolved into the total
media animals we are today – was that we figured out how to cooperate.

Or at least that’s what the Harvard guys say. Their argument runs
more or less like this:

Humans’ biggest advantage over other species is our ability to
cooÌperate. CooÌperation is difficult to establish and almost as difficult to
sustain. For any individual, freeloading is always the best course of action.
Reason developed not to enable us to solve abstract, logical problems or even
to help us draw conclusions from unfamiliar data; rather, it developed to
resolve the problems posed by living in collaborative groups.

“Reason is an adaptation to the hypersocial niche humans have
evolved for themselves,” [the Harvard guys] write. Habits of mind that seem
weird or goofy or just plain dumb from an “intellectualist” point of view prove
shrewd when seen from a social “interactionist” perspective.

It’s quite frustrating … when you think about it. But I guess it’s
better to face the truth about ourselves than to go along blindly, always
wondering over the irrational hijinks our fellow two-leggeds are forever
getting up to.

The whole sordid – but not entirely unhopeful – story is laid out
by Elizabeth Kolbert in a piece titled “Why Facts Don’t Change Our Minds,” in –
you guessed it – The New
Yorker … yes, the only rag in the greater English-speaking world
that insists on throwing an umlaut over the second o in cooperate
– like they wanted to make sure we knew how to pronounce the word or something.

This week’s Outside
the Box is truly one to make you think. And maybe meditate on how
you process data. So read on, and be relieved of your irrational bias against
the wisdom of the herd. (Or maybe, just maybe, you’ll want to help me figure
out how we’re going to save ourselves from ourselves this time.)

I find myself in Dallas, home alone while Shane is with her son
Dakota skiing in Colorado, which gives me some time to catch up with friends in
the evenings and work even harder at meeting deadlines.

And it is getting harder to meet deadlines, because I keep running
into fabulous new information that totally absorbs me, and then my friends call
me up and tell me about this or that latest innovation which is so utterly
compelling that I have to spend yet another hour listening to the story.

Even as I become increasingly alarmed at our global economic and
political process, I become more positive about the future of the human
experiment. In just the last few days Patrick Cox and I have had multiple
conversations about completely different technologies and research efforts that
have significant potential for extending not just our lifespans but our health
spans. If you are not receiving Patrick’s free letter, you are really missing out. And if
you are a serious biotech investor you should definitely be reading his subscriber letter.

We are finalizing the details on our 14th annual Strategic Investment Conference, which I guarantee you will
be the best conference I have ever put on. You need to go ahead and register
before we sell out. Once I have the last i
dotted I will give you a detailed outline of what to expect.

The weather in Dallas is absolutely fabulous. There are very few
days in Texas when I am comfortable simply turning off all the air conditioning
and/or heaters and just opening the doors and letting the house absorb the
ambience. Spring is evidently coming early almost everywhere in North America
and Europe.

You have a great week, and now let’s turn to the problems that
your and my neighbors have in dealing with facts.

Why Facts Don’t Change
Our Minds

The vaunted human capacity for reason may have
more to do with winning arguments than with thinking straight.

In 1975, researchers at Stanford invited a group of undergraduates
to take part in a study about suicide. They were presented with pairs of
suicide notes. In each pair, one note had been composed by a random individual,
the other by a person who had subsequently taken his own life. The students
were then asked to distinguish between the genuine notes and the fake ones.

Some students discovered that they had a genius for the task. Out
of twenty-five pairs of notes, they correctly identified the real one twenty-four
times. Others discovered that they were hopeless. They identified the real note
in only ten instances.

As is often the case with psychological studies, the whole setup
was a put-on. Though half the notes were indeed genuine – they’d been obtained
from the Los Angeles County coroner’s office – the scores were fictitious. The
students who’d been told they were almost always right were, on average, no
more discerning than those who had been told they were mostly wrong.

In the second phase of the study, the deception was revealed. The
students were told that the real point of the experiment was to gauge their
responses to thinking
they were right or wrong. (This, it turned out, was also a deception.) Finally,
the students were asked to estimate how many suicide notes they had actually
categorized correctly, and how many they thought an average student would get
right. At this point, something curious happened. The students in the
high-score group said that they thought they had, in fact, done quite well –
significantly better than the average student – even though, as they’d just
been told, they had zero grounds for believing this. Conversely, those who’d
been assigned to the low-score group said that they thought they had done
significantly worse than the average student – a conclusion that was equally
unfounded.

A few years later, a new set of Stanford students was recruited
for a related study. The students were handed packets of information about a
pair of firefighters, Frank K. and George H. Frank’s bio noted that, among
other things, he had a baby daughter and he liked to scuba dive. George had a
small son and played golf. The packets also included the men’s responses on
what the researchers called the Risky-Conservative Choice Test. According to
one version of the packet, Frank was a successful firefighter who, on the test,
almost always went with the safest option. In the other version, Frank also
chose the safest option, but he was a lousy firefighter who’d been put “on
report” by his supervisors several times. Once again, midway through the study,
the students were informed that they’d been misled, and that the information
they’d received was entirely fictitious. The students were then asked to
describe their own belief s. What sort of attitude toward risk did they think a
successful firefighter would have? The students who’d received the first packet
thought that he would avoid it. The students in the second group thought he’d
embrace it.

Even after the evidence “for their beliefs has been totally
refuted, people fail to make appropriate revisions in those beliefs,” the
researchers noted. In this case, the failure was “particularly impressive,” since
two data points would never have been enough information to generalize from.

The Stanford studies became famous. Coming from a group of
academics in the nineteen-seventies, the contention that people can’t think
straight was shocking. It isn’t any longer. Thousands of subsequent experiments
have confirmed (and elaborated on) this finding. As everyone who’s followed the
research – or even occasionally picked up a copy of Psychology Today – knows, any graduate student
with a clipboard can demonstrate that reasonable-seeming people are often
totally irrational. Rarely has this insight seemed more relevant than it does
right now. Still, an essential puzzle remains: How did we come to be this way?

In a new book, “The Enigma of Reason” (Harvard), the cognitive
scientists Hugo Mercier and Dan Sperber take a stab at answering this question.
Mercier, who works at a French research institute in Lyon, and Sperber, now
based at the Central European University, in Budapest, point out that reason is
an evolved trait, like bipedalism or three-color vision. It emerged on the
savannas of Africa, and has to be understood in that context.

Stripped of a lot of what might be called cognitive-science-ese,
Mercier and Sperber’s argument runs, more or less, as follows: Humans’ biggest
advantage over other species is our ability to coöperate. Coöperation is
difficult to establish and almost as difficult to sustain. For any individual,
freeloading is always the best course of action. Reason developed not to enable
us to solve abstract, logical problems or even to help us draw conclusions from
unfamiliar data; rather, it developed to resolve the problems posed by living
in collaborative groups.

“Reason is an adaptation to the hypersocial niche humans have
evolved for themselves,” Mercier and Sperber write. Habits of mind that seem
weird or goofy or just plain dumb from an “intellectualist” point of view prove
shrewd when seen from a social “interactionist” perspective.

Consider what’s become known as “confirmation bias,” the tendency
people have to embrace information that supports their beliefs and reject
information that contradicts them. Of the many forms of faulty thinking that
have been identified, confirmation bias is among the best catalogued; it’s the
subject of entire textbooks’ worth of experiments. One of the most famous of
these was conducted, again, at Stanford. For this experiment, researchers
rounded up a group of students who had opposing opinions about capital
punishment. Half the students were in favor of it and thought that it deterred
crime; the other half were against it and thought that it had no effect on
crime.

The students were asked to respond to two studies. One provided
data in support of the deterrence argument, and the other provided data that
called it into question. Both studies – you guessed it – were made up, and had
been designed to present what were, objectively speaking, equally compelling
statistics. The students who had originally supported capital punishment rated
the pro-deterrence data highly credible and the anti-deterrence data
unconvincing; the students who’d originally opposed capital punishment did the
reverse. At the end of the experiment, the students were asked once again about
their views. Those who’d started out pro-capital punishment were now even more
in favor of it; those who’d opposed it were even more hostile.

If reason is designed to generate sound judgments, then it’s hard
to conceive of a more serious design flaw than confirmation bias. Imagine,
Mercier and Sperber suggest, a mouse that thinks the way we do. Such a mouse,
“bent on confirming its belief that there are no cats around,” would soon be
dinner. To the extent that confirmation bias leads people to dismiss evidence
of new or underappreciated threats – the human equivalent of the cat around the
corner – it’s a trait that should have been selected against. The fact that
both we and it survive, Mercier and Sperber argue, proves that it must have
some adaptive function, and that function, they maintain, is related to our
“hypersociability.”

Mercier and Sperber prefer the term “myside bias.” Humans, they
point out, aren’t randomly credulous. Presented with someone else’s argument,
we’re quite adept at spotting the weaknesses. Almost invariably, the positions
we’re blind about are our own.

A recent experiment performed by Mercier and some European
colleagues neatly demonstrates this asymmetry. Participants were asked to
answer a series of simple reasoning problems. They were then asked to explain
their responses, and were given a chance to modify them if they identified
mistakes. The majority were satisfied with their original choices; fewer than
fifteen per cent changed their minds in step two.

In step three, participants were shown one of the same problems,
along with their answer and the answer of another participant, who’d come to a
different conclusion. Once again, they were given the chance to change their
responses. But a trick had been played: the answers presented to them as
someone else’s were actually their own, and vice versa. About half the
participants realized what was going on. Among the other half, suddenly people
became a lot more critical. Nearly sixty per cent now rejected the responses
that they’d earlier been satisfied with.

This lopsidedness, according to Mercier and Sperber, reflects the
task that reason evolved to perform, which is to prevent us from getting
screwed by the other members of our group. Living in small bands of
hunter-gatherers, our ancestors were primarily concerned with their social
standing, and with making sure that they weren’t the ones risking their lives
on the hunt while others loafed around in the cave. There was little advantage
in reasoning clearly, while much was to be gained from winning arguments.

Among the many, many issues our forebears didn’t worry about were
the deterrent effects of capital punishment and the ideal attributes of a
firefighter. Nor did they have to contend with fabricated studies, or fake
news, or Twitter. It’s no wonder, then, that today reason often seems to fail us.
As Mercier and Sperber write, “This is one of many cases in which the
environment changed too quickly for natural selection to catch up.”

Steven Sloman, a professor at Brown, and Philip Fernbach, a
professor at the University of Colorado, are also cognitive scientists. They,
too, believe sociability is the key to how the human mind functions or, perhaps
more pertinently, malfunctions. They begin their book, “The Knowledge Illusion:
Why We Never Think Alone” (Riverhead), with a look at toilets.

Virtually everyone in the United States, and indeed throughout the
developed world, is familiar with toilets. A typical flush toilet has a ceramic
bowl filled with water. When the handle is depressed, or the button pushed, the
water – and everything that’s been deposited in it – gets sucked into a pipe
and from there into the sewage system. But how does this actually happen?

In a study conducted at Yale, graduate students were asked to rate
their understanding of everyday devices, including toilets, zippers, and cylinder
locks. They were then asked to write detailed, step-by-step explanations of how
the devices work, and to rate their understanding again. Apparently, the effort
revealed to the students their own ignorance, because their self-assessments
dropped. (Toilets, it turns out, are more complicated than they appear.)

Sloman and Fernbach see this effect, which they call the “illusion
of explanatory depth,” just about everywhere. People believe that they know way
more than they actually do. What allows us to persist in this belief is other
people. In the case of my toilet, someone else designed it so that I can
operate it easily. This is something humans are very good at. We’ve been
relying on one another’s expertise ever since we figured out how to hunt
together, which was probably a key development in our evolutionary history. So
well do we collaborate, Sloman and Fernbach argue, that we can hardly tell
where our own understanding ends and others’ begins.

“One implication of the naturalness with which we divide cognitive
labor,” they write, is that there’s “no sharp boundary between one person’s
ideas and knowledge” and “those of other members” of the group.

This borderlessness, or, if you prefer, confusion, is also crucial
to what we consider progress. As people invented new tools for new ways of
living, they simultaneously created new realms of ignorance; if everyone had
insisted on, say, mastering the principles of metalworking before picking up a
knife, the Bronze Age wouldn’t have amounted to much. When it comes to new
technologies, incomplete understanding is empowering.

Where it gets us into trouble, according to Sloman and Fernbach,
is in the political domain. It’s one thing for me to flush a toilet without
knowing how it operates, and another for me to favor (or oppose) an immigration
ban without knowing what I’m talking about. Sloman and Fernbach cite a survey
conducted in 2014, not long after Russia annexed the Ukrainian territory of
Crimea. Respondents were asked how they thought the U.S. should react, and also
whether they could identify Ukraine on a map. The farther off base they were
about the geography, the more likely they were to favor military intervention.
(Respondents were so unsure of Ukraine’s location that the median guess was
wrong by eighteen hundred miles, roughly the distance from Kiev to Madrid.)

Surveys on many other issues have yielded similarly dismaying
results. “As a rule, strong feelings about issues do not emerge from deep
understanding,” Sloman and Fernbach write. And here our dependence on other
minds reinforces the problem. If your position on, say, the Affordable Care Act
is baseless and I rely on it, then my opinion is also baseless. When I talk to
Tom and he decides he agrees with me, his opinion is also baseless, but now
that the three of us concur we feel that much more smug about our views. If we
all now dismiss as unconvincing any information that contradicts our opinion,
you get, well, the Trump Administration.

“This is how a community of knowledge can become dangerous,” Sloman
and Fernbach observe. The two have performed their own version of the toilet
experiment, substituting public policy for household gadgets. In a study
conducted in 2012, they asked people for their stance on questions like: Should
there be a single-payer health-care system? Or merit-based pay for teachers?
Participants were asked to rate their positions depending on how strongly they
agreed or disagreed with the proposals. Next, they were instructed to explain,
in as much detail as they could, the impacts of implementing each one. Most
people at this point ran into trouble. Asked once again to rate their views,
they ratcheted down the intensity, so that they either agreed or disagreed less
vehemently.

Sloman and Fernbach see in this result a little candle for a dark
world. If we – or our friends or the pundits on CNN – spent less time
pontificating and more trying to work through the implications of policy
proposals, we’d realize how clueless we are and moderate our views. This, they
write, “may be the only form of thinking that will shatter the illusion of
explanatory depth and change people’s attitudes.”

One way to look at science is as a system that corrects for
people’s natural inclinations. In a well-run laboratory, there’s no room for
myside bias; the results have to be reproducible in other laboratories, by
researchers who have no motive to confirm them. And this, it could be argued,
is why the system has proved so successful. At any given moment, a field may be
dominated by squabbles, but, in the end, the methodology prevails. Science
moves forward, even as we remain stuck in place.

In “Denying to the Grave: Why We Ignore the Facts That Will Save
Us” (Oxford), Jack Gorman, a psychiatrist, and his daughter, Sara Gorman, a
public-health specialist, probe the gap between what science tells us and what
we tell ourselves. Their concern is with those persistent beliefs which are not
just demonstrably false but also potentially deadly, like the conviction that
vaccines are hazardous. Of course, what’s hazardous is not being vaccinated; that’s
why vaccines were created in the first place. “Immunization is one of the
triumphs of modern medicine,” the Gormans note. But no matter how many
scientific studies conclude that vaccines are safe, and that there’s no link between
immunizations and autism, anti-vaxxers remain unmoved. (They can now count on
their side – sort of – Donald Trump, who has said that, although he and his
wife had their son, Barron, vaccinated, they refused to do so on t he timetable
recommended by pediatricians.)

The Gormans, too, argue that ways of thinking that now seem
self-destructive must at some point have been adaptive. And they, too, dedicate
many pages to confirmation bias, which, they claim, has a physiological
component. They cite research suggesting that people experience genuine
pleasure – a rush of dopamine – when processing information that supports their
beliefs. “It feels good to ‘stick to our guns’ even if we are wrong,” they
observe.

The Gormans don’t just want to catalogue the ways we go wrong; they
want to correct for them. There must be some way, they maintain, to convince
people that vaccines are good for kids, and handguns are dangerous. (Another
widespread but statistically insupportable belief they’d like to discredit is
that owning a gun makes you safer.) But here they encounter the very problems
they have enumerated. Providing people with accurate information doesn’t seem
to help; they simply discount it. Appealing to their emotions may work better,
but doing so is obviously antithetical to the goal of promoting sound science.
“The challenge that remains,” they write toward the end of their book, “is to
figure out how to address the tendencies that lead to false scientific belief.”

“The Enigma of Reason,” “The Knowledge Illusion,” and “Denying to
the Grave” were all written before the November election. And yet they
anticipate Kellyanne Conway and the rise of “alternative facts.” These days, it
can feel as if the entire country has been given over to a vast psychological
experiment being run either by no one or by Steve Bannon. Rational agents would
be able to think their way to a solution. But, on this matter, the literature
is not reassuring.

The exchange-traded-fund industry is much like Greek life on a college campus: It’s a bit rowdy and full of friendly competition, everyone speaks in letters as shorthand, and they all grew up together, in a sense. Put four industry leaders in a room and the ebullient trash-talking immediately begins.

But these four are some of the best minds in the fast-growing, yet also maturing, business. There’s $2.8 trillion in 2,000 ETFs in the U.S., according to research firm XTF, but those figures belie the extremely concentrated makeup of the industry. More than 80% of assets are held in just three firms—Vanguard, BlackRock and State Street (STT)—all of which are represented at this roundtable.

Joel Dickson is global head of investment research and development for Vanguard Group, which manages $4 trillion in assets, including $600 billion in 70 ETFs. Mark Wiedman is global head of iShares and Index Investments at BlackRock, which has $5 trillion in assets under management, $1 trillion of which is in its 334 or so iShares ETFs. Jim Ross is executive vice president of State Street Global Advisors and global head of SPDR ETFs. The $2.5 trillion firm is home to $450 billion in ETFs, including the oldest and largest, the $242 billion SPDR S&P 500 (ticker: SPY).

Tony Rochte is president of Fidelity Investments’ SelectCo, its sector investing unit. Prior to joining Fidelity in 2012, he had six-year stints at both State Street and iShares when it was owned by Barclays.

Fidelity, which manages $2.2 trillion, has $6 billion in its own ETFs, a relatively small figure, though impressive, given that it essentially began its ETF business just three years ago. Its brokerage arm has $270 billion in ETF assets under administration.

While traditional mutual funds still hold the lion’s share of fund assets, with $16.5 trillion, ETFs are coming on strong, with twice as much in assets as they held just four years ago. To learn what the future may hold, read on.

Barron’s: Let’s dispense with the topic absolutely no one here wants to discuss—the active-versus-passive debate.

Jim Ross: This is a pretty tired debate. ETFs are thrown in on the passive side, yet they’re used for active implementation by probably more than 50% of the people using them.

Tony Rochte: This debate doesn’t even exist if you talk to a professional. Financial advisors view themselves as architects using building blocks, index products alongside actively managed funds.

That’s how we think about it, as well.

Mark Wiedman: We reject even the idea of active versus passive. All portfolios are active. How you build that portfolio is an active decision. When people talk about active versus passive, they are really talking about price—high-cost versus low-cost funds.

Rochte: Price is critical, especially as advisors move to a fee-based model. According to Cerulli Associates, in 2004, 21% of the advisor market was 100% commission-only and 41% was fee-based.

At the end of 2015, only 3% of advisors had a purely commission business, and almost 80% were fee-based. It is not just individual investors looking for low-cost products; it is a change in the advisory business that’s really a tail wind for the growth of ETFs.

There has been a lot of talk about passive being a bubble or worse, while others, Barron’s included, have argued that the more money that goes into passive strategies, the more opportunity there will be for stockpickers.

Wiedman: That is dead right, but 25 years too early. Only one-sixth, or 16%, of the U.S. stock market is indexed. We are literally trillions away from an “over-indexed” world. We’ll know when we get there—when active managers on the whole produce neutral returns, net of fees.

Joel Dickson: I disagree a bit with that…

Wiedman: Game on.

Dickson: Yeah. The last few decades have seen a big shift into professional management among what were formerly retail investors. That changes things. If someone is going to have consistent stock-picking success, somebody else has to consistently lose. That used to be the retail investor. You can see this in the Federal Reserve’s flow of funds data over the past 45 years. We’ve gone from 20% of household assets under professional management to now more than 60%. And that’s probably understated. Outperformance is harder when everyone is a professional.

Wiedman: Actually, I agree with Joel. As the world has become much more institutionalized, competition has gotten much more intense. Trillions have flowed into all forms of institutional money management, and they are competing against each other in a zero-sum game.

Do advisors and retail investors use ETFs differently?

Rochte: Individual investors and advisors are both focused on asset allocation and unique exposures.

We looked at the 18 million brokerage accounts—just over 40% of our platform are retail investors and 57% are advisors—and found that the retail segment is growing faster, and it skews towards high-net-worth, sophisticated investors. The average holding period for equity ETFs is almost 20 months.

Dickson: At Vanguard, it is just under three years for ETFs; 3½ for mutual funds.

Wiedman: You actually let your investors sell?

Dickson: Every now and then.

Do investors have the right tools to evaluate exchange-traded funds?

Ross: I worry constantly about the number of ETFs and whether investors understand what’s in them, and how they will meet their goals. But the tools are available.

Wiedman: The market has spoken; clients have voted—almost 100% of the money going into ETFs is going to simple vehicles from established firms. There are thousands of ETFs, but investors have figured out how to find the good ones.

So your unbiased opinion is that because Vanguard, iShares, and State Street ETFs took in $243 billion, or 87% of all ETF inflows for 2016, that’s evidence that investors are well informed. OK. What don’t they know?

Dickson: That ETFs trade all the time is an overstated advantage. The market environment for an ETF is not just the value of the underlying securities; it’s also the premium and discount of the ETF itself. With a mutual fund, your trade won’t settle until 4 p.m., but you know you’re going to get the value of the underlying securities. ETFs are price-certain; you know what price you’re buying or selling them at, which could be different than the value of the underlying securities. Mutual funds are value-certain; you may not know what the price will be, but you’ll get the value of the stocks it holds—no more, no less. That’s the trade-off.

Wiedman: That’s like saying I’m going to close my eyes, and since I don’t get the price until 4 p.m. I’ll feel better. The advantage of the ETF is you know exactly the price you are getting. The concern is not the ETF; it’s the fragility of the U.S. equity markets. Dealers and investment banks are smaller, and they are not able to commit capital under stress. Institutions have to be careful about throwing orders into a yawning gap at the open or the close when volatility can strike. The ETF just makes naked the underlying pricing volatility that already exists.

What do you mean, the market is fragile?

Wiedman: Equity markets depend on market makers to price securities. Those market makers used to be well-known global banks, but since the financial crisis, those banks have faced regulations that make the cost of capital more expensive, and therefore market-making more expensive. While the daily market is still very liquid, during a stress event, like a macroeconomic shock, the ability of banks to step in has been greatly reduced. The markets today are effectively priced by small firms no one has ever heard of, and they are not equipped to operate in times of stress.

Dickson: The fragility is not the market-making community. Exchanges need to be modernized for the types of instruments people are now trading. The centralization is not there to get the imbalances appropriately dealt with. We as an industry have been trying to get the exchanges to think about that.

Yes, especially since Aug. 24, 2015, when high volatility caused prices for U.S. equity ETFs to fall much further than those of the stocks they owned. Market makers were flying blind—unable or unwilling to take the risk inherent in setting fair prices. There were nearly 1,300 separate five-minute trading halts in more than 400 stocks and ETFs, and a fifth of all ETFs fell more than 20%, while just 5% of individual stocks declined by that much. All of this happened after rules had been implemented in the wake of the 2010 flash crash. So what needs to happen now?

State Street’s Jim Ross says that ETFs can help investors during market shocks. Ken Schles for Barron's

Ross: The exchanges don’t have consistent rules around opening trading in a stock. It’s not because they’re looking for a competitive advantage; it’s just how they’ve grown. All the firms here, along with many others in the industry, have formed a coalition to work with market makers, the exchanges, regulators, and others within the ETF ecosystem to harmonize some of these rules.

Dickson: There is a bit of a mismatch in terms of how trading reopens in a security that has been halted, so there can be unintended consequences on days of marketwide volatility. Historically, most rules around market structure have focused on preventing fallout from single-security events. We need to change that focus to how extreme events affect baskets of securities, like ETFs.

Wiedman: In times of severe stress, traders need harmonization and simple market protocols so they don’t need to think very hard about whether to buy or sell. That’s an important part of protecting U.S. equity markets and the ETFs that depend on it.

How can investors protect themselves?

Ross: There will, at times, be tons of volatility in the market—don’t trade at those times.

Wiedman: There’s another very simple rule for investors: Don’t use market orders. Use limit orders.

Market orders are filled at the going price; limit orders require investors to decide at what price they’re willing to buy or sell, limiting the risk of paying too much or selling too low. If limit orders are the best way to trade, why is the default option on almost every brokerage platform—including Fidelity’s and Vanguard’s—a market order?

Dickson: Some of this is just legacy practice. There is also a client-service and customer-risk element to the market/limit order debate. A market order says, “I want to purchase the security now, regardless of price.” If you don’t fill that request—even if it’s in the investor’s interest to put some price protection around the trade—you’re opening yourself up to a decent amount of liability in not having followed the customer’s orders. There are also client-servicing issues—what if the client is buying and selling at the same time, and one part of their trade goes through, but the other doesn’t? Now you’ve got a settlement problem.

Wiedman: The real story here is that ETFs work literally almost every second. They trade when the underlying markets are troubled or even closed. You can buy and sell Japanese equities right now, even though the markets in Japan are closed. That’s magic.

Ross: ETFs trade well virtually all the time. SPY has traded at less than a penny spread for 3,000 consecutive trading days.

Rochte: After 9/11, SPY was used as a price-discovery mechanism. The same was true for single-country ETFs as far back as the Asian contagion in the late 1990s.

How does an exchange-traded fund act as a mechanism for price discovery?

Ross: Regarding Sept. 11, a lot of stocks hadn’t begun trading when the market opened, but SPY was trading, using prices from the previous close for some stocks. As those stocks opened, the index value went to where the ETF was trading. When everything opened, it all converged.

Wiedman: People use ETFs in stressful markets to define the new price. It is where liquidity pools find new prices. One of the great examples of this was in the high-yield crunch in December 2015, when the best way to gauge the price of high yield bonds was to look at two different ETFs—HYG and some other ticker.

Those two ETFs accounted for more than half of all high-yield trading on one day, 25% for the month.

Ross: Another important distinction is the transparency. That same December, there was a mutual fund [Third Avenue Focused Credit] that caused a lot of consternation because it couldn’t sell some of its holdings. An ETF wouldn’t have had the same problems because the ETF provider could do an in-kind exchange. Also, investors would have seen the holdings and the prices every day.

The ETF industry is remarkably concentrated in terms of assets and products. There are 2,000 ETFs, yet just 19 or 20 of them from your firms account for more than a third of all ETF assets. Can this domination continue? What happens to the dozens of firms and hundreds of ETFs that make up the rest of the market?

Wiedman: I’m trying to think of an answer that I can give in public. Jim, your reaction?

Ross: I’ll answer it. First of all, we’ve seen many dozens of new ETF sponsors in the last three to five years.

There are also ETF start-ups that have grown up, like WisdomTree, which is now the fifth largest ETF sponsor in the U.S. Can that continue? Yes. There is opportunity for new entrants. Also, the fastest-growing ETF markets are outside the U.S. The industry could get to $25 trillion by the end of 2025.

Rochte: That’s an aggressive number. We don’t have the manufacturing capability that the three gentlemen next to me do at their firms. But we have a big platform; our brokerage handles 11% of U.S. ETF business.

You’ve also launched 20 ETFs in the past few years—starting with 11 sector ETFs in 2013, three actively managed bond ETFs a year later, and six factor ETFs last fall—and now you have $6 billion in Fidelity ETFs.

Rochte: Over the past five years, only five firms have raised more than $1 billion in ETFs, according to Credit Suisse; Fidelity is one of them. More than 50 ETF players have less than $1 billion in assets.

We have a partnership with BlackRock for core passive ETFs; they do it very well. When it comes to manufacturing our own ETFs, we want to add expertise or real differentiation.

Wiedman: The barriers to entry are very low; barriers to success are much higher.

What are the barriers to success?

Wiedman: There’s not a crying need for new entrants to come in and compete with broad-market exchange-traded funds at rock-bottom prices. Instead, they are coming in with niche, higher-priced products.

Dickson: Four out of every five dollars in ETFs are in broad-market, capitalization-weighted funds.

That said, though the three of us have 82% of the market, we are the ones fiercely competing on price.

Wiedman: We have a brutally competitive, concentrated marketplace.

Dickson: True. But this concentration wasn’t BlackRock’s decision or Vanguard’s decision or State Street’s decision—it is a result of the independent decisions of millions of investors, choosing the products they think best meet their goals.

Rochte: New products must differentiate themselves. And distribution is critical.

Dickson: That’s true. You’ve got providers throwing spaghetti against the wall and hoping something sticks. If it does, it can be very profitable, but you are going to be a smaller player. New entrants with brand names and good distribution, like Fidelity, Schwab, or Pimco, can get assets early on.

Rochte: Consolidation among smaller firms will continue.

How does the industry grow?

Rochte: The next decade is not about new products. It’s about wrapping ETFs in an active strategy. That can be via a robo-advisor, or sophisticated ETF strategist, or firms that provide “paper portfolios” for advisors to implement.

Ross: I’m going to completely disagree with Tony, because I really enjoy doing that. It’s true that packaging ETFs is a growing business; we offer ETF managed portfolios, as does everyone else at this table. But the underlying growth is the ETF usage itself. We’ll see new products, especially in what everyone but me likes to call smart beta.

Nobody likes to call it that, but no one has come up with a better alternative.

Ross: I think all four of us agree with that.

Smart beta is a broad term for an index organized around an investing philosophy, rather than weighting stocks according to their market capitalization, as most ETFs do.

Rochte: Academic research has shown that four factors—quality, value, momentum, and volatility—perform very well over time. But they don’t perform well all of the time.

Ross: The challenge with smart beta, whether it is single factor or multi-factor, is that you have to stay the course.

Dickson: We now have upward of 30 low-volatility ETFs. How do you differentiate among them?

“Education” ends up being marketing from 30 different providers. So people look to performance as the indicator of the better product. That’s a real worry. It is just like traditional active management; there are long periods of underperformance. Not only do you have to stick with it; you have to rebalance to it.

Flows into smart-beta ETFs are down—nearly $70 billion went into smart-beta ETFs in both 2014 and 2015. Last year, it was less than $40 billion. That’s a big drop.

Ross: There is a bit of fatigue around smart beta. People don’t know how to evaluate them. I’m going to predict the future here, which is really a bad thing.

Wiedman: Go for it. Just don’t put a date on it.

Ross: I’ll put a date on it. In five years, there will be a headline in Barron’s saying that retail investors have underperformed using smart beta.

Dickson: They already have.

They have—and I think we’ve used that headline already.

Ross: You can reuse headlines. This gets back to due diligence. If you don’t have conviction in an ETF, don’t invest in it.

Rochte: There can be unintended consequences with factor investing. Look at the MSCI Momentum index in the last quarter of 2016; it was underweight financials. Financial stocks rose tremendously after the election in November. That’s why our factor ETFs are sector neutral.

What other areas are ripe for new products?

Wiedman: Most growth in the next five years will come from new clients, and deeper penetration with existing clients. But in terms of new products, fixed income is massively under-indexed. Investors think about just one major index, which skews heavily toward the countries and companies that issue the most debt. Bond indexes need to be reconsidered.

You’re referring to the Bloomberg Barclays U.S. Aggregate Bond Index, better known as the Agg?

Wiedman: Yes. Many active managers just buy whatever is not in the Agg, like emerging market bonds, in order to beat it.

Ross: We’re having an active/passive debate, if I’m hearing this right.

Wiedman: No, we’re talking about the decomposition of what really is beta return.

Ross: I agree 100% the Agg is not a great benchmark. Active managers have outperformed it on a routine basis in the past one, three, and five years.

Dickson: We can debate the merit of factor investing in stocks, but in fixed income there are clearly two factors that drive the market—rate and credit.

Wiedman: This is important, what Joel is getting at. The great active managers, including those at our firm, spend a lot of time thinking about how to manage rate and credit risk efficiently. What doesn’t yet exist in the fixed-income world is a careful analysis and decomposition of how much of an active manager’s return comes from simply riding those risks, versus security selection. In equities, that’s the whole game. In fixed income, that conversation hasn’t really begun. The Agg is the only frame of reference for many investors. We can do smarter indexing, either via indexes that capture more of the market, like IUSB, which includes emerging market debt, or indexes that target investor goals, such as higher income or shorter duration.

So a lot of ETF growth will come from fixed income?

Ross: Yes, especially as insurance companies continue to understand the fundamental changes going on in fixed income, they will look to ETFs.

Wiedman: Institutional managers of all kinds struggle to trade bonds cheaply. They have to pay a lot more today to trade fixed-income than they did before the financial crisis.

How will robo-advisors, which offer investors asset-allocation models at much lower prices than they’d pay a human advisor, change the ETF business?

Wiedman: Robo technology will change the world, but when we talk about robo-advisors, we’re mostly talking about stand-alone players that don’t have any friends. Online-only banks died, but online banking conquered. Robo technology, especially from the players at this table, could transform wealth management. ETFs will get sucked into that.

Dickson: The disruption of robos is not that they use ETFs; it’s in how investors get their portfolios. Robos lock people into an advisory relationship much earlier, and that money is usually fairly sticky.

Wiedman: The Silicon Valley robos are not going to be around long enough to enjoy that sticky money. Their cost of client acquisition is too high, as are the regulatory hurdles. Robos will change the way investors expect to be advised, and they are going to reset the price. But it’s the established wealth managers who will win. Joel, what’s the price on your service?

Dickson: It’s staggered, but it starts at 30 basis points [0.3%] and goes down, the more assets you have.

Wiedman: That’s the revolution.

Rochte: What industry hasn’t been disrupted by technology? Even the full-service broker/dealers are building digital advice models. Financial firms spent $19 billion on fintech last year. But whether it’s competition or “co-opetition” remains to be seen.

The polite fiction that there is only one China has kept the peace in East Asia—but now it is coming under pressure from all directions.BEIJING AND TAIPEI

WHEN Donald Trump, then America’s president-elect, said on December 11th that “I don’t know why we have to be bound by a one-China policy” he ripped aside one of the oldest sticking-plasters in the world of diplomacy. That he stuck it back on again two months later, telling Xi Jinping, China’s president, that he would honour the one-China policy “at President Xi’s request”, does not alter the fact that an American leader had questioned a basic feature of Asian security. Nor does Mr Trump’s reversal solve problems with the one-China formula, on which peace between Taiwan and China has depended, that were evident well before his election. If they worsen, the two sides’ frozen conflict could heat up.The one-China formula is not so much fraught with ambiguities as composed of them. China itself does not actually have a one-China policy. It has what it calls a one-China principle, which is that there is only one China, with its government in Beijing. It regards Taiwan as a renegade Chinese province and refuses diplomatic recognition to any country that recognises Taiwan as a state. Yet this rigid principle can be bent. In 2015 President Xi met the island’s then-president, Ma Ying-jeou, for what would have looked to innocent eyes very much like a bilateral summit of heads of state. And China looks the other way, albeit with some fulmination, when America sells arms to Taiwan—a traffic which, in 1982, America said it would phase out, but continues to this day.

America does not accept the one-China principle. Instead it has the one-China policy, which acknowledges that China has such a principle—not quite the same thing. America does not recognise Chinese sovereignty over Taiwan, nor does it recognise Taiwan as an independent state. It does plenty of trade with it, though. Small as it is, Taiwan is the ninth-largest buyer of American exports, outstripping Italy and India. America’s unofficial ties with the island are closer than many countries’ diplomatic links. The American Institute in Taiwan, a private not-for-profit institution with headquarters in Washington, DC, looks like an embassy and acts like one, too. The Taiwan Relations Act of 1979 commits America to helping Taiwan defend itself against invasion and embargoes, deeming any coercion of the island to be “of grave concern to the United States”.In Taiwan itself the one-China formula has an even stranger history. It is rooted in the fiction that the island’s first president, Chiang Kai-shek, who fled there in 1949 after losing a civil war to Mao Zedong’s communists, would one day recapture the whole of China. Hence Taiwan’s official name, the Republic of China. Thus the party that Chiang led, the Kuomintang (KMT), and the Chinese government can both subscribe to an agreement called the “1992 consensus”, which says that there is only one China but recognises that the two sides disagree about what that means in practice, thus piling fudge upon ambiguity. Taiwan’s other major political party, the Democratic Progressive Party (DPP), rejects both the 1992 consensus and the one-China principle more generally. But its leader, Tsai Ing-wen, who succeeded the KMT’s Mr Ma as president last year, prefers not to do so openly.In most areas of politics this surfeit of uncertainty would be worrying. Yet the agreement not to look too closely at the contradiction of “one China” has kept an uneasy peace across the Taiwan Strait. There have been political crises—most recently in the mid 2000s—and in 1996 China fired missiles towards the island while Chinese leaders scowled for the cameras. But by and large it has worked well enough for all three sides to want to maintain it.Their reasons differ, just as their reading of the formula does. China believes that time is on its side. As the motherland becomes ever wealthier and more powerful, its leaders seem genuinely to hope that Taiwan’s people will want to rejoin it. Taiwan’s leaders think the opposite; that with time the island’s people will see themselves as having less and less in common with the mainland. Since the 1992 consensus, the proportion of people on the island who identify themselves simply as Taiwanese has more than tripled to almost 60%; the share of those who call themselves Chinese has plunged to just 3% (see chart). Among people between 20 and 30, 85% say they are Taiwanese. In America the attitude is a simpler ain’t-broke-don’t-fix-it one. The status quo enables the country to have diplomatic ties with China without breaking off links with Taiwan, and that is good enough.But this equilibrium of incommensurable interests depends on certain conditions being right: that China continues to get richer, confirming its leaders’ optimism; that people on each side of the strait do not come to see each other as enemies; that Asia remains more or less stable, so the sides do not get caught up in other conflicts; and that, if the worst comes to the worst, America’s armed forces will step in to keep the peace.All these conditions are now changing. China’s economy has been slowing. And Asia is no longer so stable. Mr Trump has threatened to impose tariffs on Chinese exports, risking a trade war. Chinese territorial claims over various islands are heightening tensions: America’s secretary of state, Rex Tillerson, told the Senate that America must be able to limit Chinese access to disputed islands in the South China Sea. Mr Trump confirmed to Shinzo Abe, Japan’s prime minister, that their two countries’ defence treaty covers the Senkaku islands, which China calls the Diaoyu.And while Mr Trump and Mr Abe were meeting, North Korea conducted its first post-Trump missile test. A month before, North Korea’s leader, Kim Jong Un, had claimed his country would soon test its first intercontinental ballistic missile, which could hit the American mainland, though that was not what was tested. In response to Mr Kim’s threats America is fielding a missile-defence system in South Korea—to which China vociferously objects.Taiwan might seem like the eye of the storm. Yet China still holds a threat of invasion, or blockade, over the island, and it sometimes shows signs of wanting to bring things towards a head. In 2013 Mr Xi sent a tremor across the strait when he told Vincent Siew, Taiwan’s vice-president, that their conflict “cannot be passed on from generation to generation”. It sounded as if the president’s patience was starting to wear thin. On March 6th the head of the Taiwan Relations Office, a government department, said to the National People’s Congress (NPC), China’s rubber-stamp parliament, that “I have to emphasise that Taiwan’s independence...will lead nowhere. I hope the Taiwan government will think about this sentence carefully.” All this is in the context of a military balance that has been shifted by a decade of double-digit increases in Chinese spending. Ten years ago Pentagon planners dismissed the idea of an invasion as “the million-man swim”. You don’t hear such nonchalance much these days.

Strait and narrow

America might no longer be able to dispatch two aircraft-carrier groups to the Taiwan Strait to force China to back down, as it did in 1996. But if hostilities were to break out America would almost surely be drawn in. The Taiwan Relations Act does not fully oblige it to, but to refrain would be a mortal blow to its position and prestige as a superpower. There would also be economic considerations: Taiwan makes more than a fifth of the world’s semiconductors; a Chinese blockade could cripple the computer industry.Against such a backdrop, the election of Ms Tsai of the independence-minded DPP was always likely to ratchet up tension. Soon after her inauguration last May the government in Beijing cut off communications between China’s Taiwan Affairs Office and Taiwan’s Mainland Affairs Council, increasing the chances of misunderstanding and miscalculation.On November 25th China flew a pair of Xi’an H-6K bombers round the island, along with some escorts. Two weeks later another Xi’an bomber and three fighter jets again circled Taiwan. Then in January China’s aircraft-carrier, the Liaoning, sailed round the southern tip of Taiwan and into the Taiwan Strait. “It shows they mean business,” says Andrew Yang, a former Taiwanese deputy defence minister.Chinese pressure on Taiwan could increase further. The five-yearly Communist Party congress is due near the end of this year and Mr Xi may be tempted to burnish his hawkish credentials by holding several sabre-rattling military exercises in the run up. He could deplete Taiwan’s tally of 21 diplomatic partners. There have also been reports that China is considering amending its “anti-secession” law. At the moment it says that China would consider taking “non-peaceful methods to defend the nation’s sovereignty” only if Taiwan formally declared independence or if there is no hope of a peaceful resolution. On February 7th Yomiuri Shimbun, a Japanese newspaper, reported that China is thinking about amending this to say it could invade if Taiwan’s leader refuses to endorse the 1992 consensus—a refusal to which the DPP has so far stuck. During the NPC, a Chinese admiral, Yin Zhuo, said China should use the anti-secession law to make it clear to Taiwan that “independence means war.”Relations between China and Taiwan have been through fraught times before, though, without breaking down completely. And there are three reasons for thinking that, in the short term at least, things will not go horribly wrong this time.Both Mr Xi and Ms Tsai have strong domestic reasons for setting aside their differences for a while. Mr Xi is consumed by the party congress, and though he may want to make himself appear tough with a few bellicose gestures he does not want a distracting crisis. As for Ms Tsai, she knows that her chances of re-election in 2020 depend on her handling of the economy, not on her handling of China. Taiwanese GDP growth and wages are flat. Her opinion-poll ratings are dismal. She is about to launch a politically risky reform of the bankrupt state-run pensions system. The last thing she wants is a fight with a superpower.A second reason for guarded optimism is that Ms Tsai has taken the DPP further towards China’s position than ever before. At her inauguration she said that she recognised the “historical fact” of the 1992 negotiations, which is as near as she can get to accepting the consensus without actually doing so. In a speech in October she reassured the communist government that she “will, of course, not revert to the old path of confrontation”. Ms Tsai is a trade lawyer, cautious, predictable and restrained—everything her risk-taking DPP predecessor, Chen Shui-bian, the president from 2000 to 2008, was not. China’s condescension towards her—the Taiwan Affairs Office called her inaugural address “an incomplete examination answer” as if she were a stupid schoolgirl—has been mild compared with the invective levelled against previous DPP leaders, whom they have called “insane”, “evil” and “scum”. That may mean Mr Xi wants to keep open the door for future negotiations.Third, the military balance in the Taiwan Strait has not swung far enough for China’s high command to be confident of swift victory. If the country could sweep into Taiwan so fast the world did not have time to react (as when Russia invaded Crimea) other countries might conceivably treat an invasion as a fait accompli. But Taiwan is no Crimea. Only 10% of the population wants unification and less than 2% wants it as soon as possible. The island has a vibrant civil society capable of putting millions of protesters onto the streets against a Taiwanese government, let alone a Chinese occupying force.The mainland has around 1,400 land-based missiles aimed at Taiwan, plus an unknown number of air- and sea-launched ones. Despite the presence of anti-missile defences—both American Patriot missiles and Taiwan’s own systems—the island’s air bases and many of its other defences might be quickly destroyed by all that firepower. But an invasion requires troops on the ground—ground which, in this case, lies the other side of 180km of open water. And Taiwan’s surviving forces could make that voyage very unpleasant. Mr Yang says that, for an invasion to succeed, China would need promptly to destroy 85% or more of Taiwan’s own missiles; if half of Taiwan’s missiles survived the first wave of attacks, China’s invasion force would be vulnerable.

Ex uno, plures

If the invasion could be slowed down, other countries would have time to react. At that point, any Chinese leader would have to decide whether to stop the invasion or risk a wider conflict. He would surely push on for fear of what might happen at home if he backed down. But he would just as surely prefer to avoid such a choice altogether. And that is where Taiwan’s real deterrence lies: it does not need to be able to turn back an invasion; it only needs to be able to buy enough time to force on China the choice between a coup at home and a regional war abroad.Without the assurance of a quick victory, cleaving to the familiar ambiguities of “one China” will make the most sense to China’s leader. But those ambiguities will become ever more difficult to maintain. Mr Trump may yet return to his doubts about American support for the policy; it would hardly be the first time he has changed his mind. And popular attitudes across the strait are hardening. It is not just that islanders increasingly see themselves as Taiwanese; mainlanders, who used to regard the Taiwanese as brothers, have started taking a chillier attitude. They still see the islanders as part of the same culture, but they are now imposing loyalty tests, demanding (for example) a boycott of Taiwanese entertainers who last year did not condemn an international tribunal’s ruling against Chinese claims in the South China Sea. The Communist Youth League, long a training ground for ruling party officials, waged a social-media campaign against one well-known Taiwanese performer in China, Leon Dai, and got him blacklisted.Chinese officials are encouraging suspicion. The number of Chinese tourists to Taiwan has fallen by more than a third in the past year, largely because bureaucrats have made it harder to travel. Chinese universities have also asked Shih Hsin University, in Taiwan, not to discuss “sensitive political subjects” (such as the one-China principle) with exchange students from the mainland. A senior KMT official fears the days of pro-Taiwan sentiment on the mainland may be over.Political attitudes are hardening, too. Taiwan used to have a one-China party, the KMT, and a party that preferred independence, the DPP. But the KMT is in free fall after its defeat in last year’s election. The fastest rising force is the New Power Party, which has its roots in student demonstrations against close ties with China; it is at least as anti-one-China as the DPP. Mr Xi’s crackdown on dissent and civil society is leading the political system ever further from Taiwan’s vibrant democracy. The Beijing government’s interference in Hong Kong’s local politics is taken to show that “one country, two systems”, a formula devised for Hong Kong and once offered to Taiwan, is a fraud.In the face of these realities, both sides want the option of continuing to say that the one-China framework holds, and looking for fresh obfuscations to that end—new helpings of fudge to put on top of that served up in the 1992 consensus. In 2011 Wang Yi, now China’s foreign minister, then head of the Taiwan Affairs Office, said privately during a visit to Washington that China might consider replacing the 1992 formula, and there have been some signs that this could still be on the cards. Every two weeks Taiwanese officials meet to sift through new forms of words. A new formula might conceivably provide the basis of future talks.The simple and natural solution is to admit there are two Chinas. But the communist government is not ready to do that. Instead, it is forcing the Taiwanese and Americans to deal with the fraying ambiguities of a one-China policy, as all three move slowly towards a new, more dangerous endgame.

If you know the other and know yourself, you need not fear the result of a hundred battles.

Sun Tzu

We are travelers on a cosmic journey, stardust, swirling and dancing in the eddies and whirlpools of infinity. Life is eternal. We have stopped for a moment to encounter each other, to meet, to love, to share.This is a precious moment. It is a little parenthesis in eternity.